Introduction to Finance Study Guide Questions
Course Introduction
Introduction to Finance provides students with a foundational understanding of key financial principles and concepts, including the time value of money, risk and return, financial markets and institutions, and the basics of investment and corporate finance. The course explores how individuals, businesses, and organizations make financial decisions, emphasizing tools and techniques used to analyze financial information, assess investment opportunities, and manage financial resources efficiently. Through lectures, case studies, and practical exercises, students gain essential skills for effective financial decision-making applicable both in personal and professional contexts.
Recommended Textbook Fundamentals of Financial Management 15th Edition by Eugene F. Brigham
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Page 2
Chapter 1: An Overview of Financial Management
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Sample Questions
Q1) Which of the following statements is CORRECT?
A) Corporations face few regulations and more favorable tax treatment than do proprietorships and partnerships.
B) Managers who face the threat of hostile takeovers are less likely to pursue policies that maximize shareholder value compared to managers who do not face the threat of hostile takeovers.
C) Bond covenants are an effective way to resolve conflicts between shareholders and managers.
D) Because of their simplified organization,it is easier for proprietors and partnerships to raise large amounts of outside capital than it is for corporations.
E) One advantage to forming a corporation is that the owners of the firm have limited liability.
Answer: E
Q2) As a result of financial scandals occurring during the past decade,there has been a strong push to improve business ethics.
A)True
B)False
Answer: True
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Page 3
Chapter 2: Financial Markets and Institutions
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Q1) If you wanted to know what rate of return stocks have provided in the past,you could examine data on the Dow Jones Industrial Index,the S&P 500 Index,or the NASDAQ Index.
A)True
B)False
Answer: True
Q2) The annual rate of return on any given stock can be found as the stock's dividend for the year plus the change in the stock's price during the year,divided by its beginning-of-year price.
A)True
B)False Answer: True
Q3) A publicly owned corporation is a company whose shares are held by the investing public,which may include other corporations as well as institutional investors.
A)True
B)False
Answer: True
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Page 4
Chapter 3: Financial Statements,cash Flow and Taxes
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Sample Questions
Q1) Both interest and dividends paid by a corporation are deductible operating expenses,hence they decrease the firm's taxes.
A)True
B)False
Answer: False
Q2) Austin Financial recently announced that its net income increased sharply from the previous year,yet its net cash provided from operations declined.Which of the following could explain this performance?
A) The company's dividend payment to common stockholders declined.
B) The company's expenditures on fixed assets declined.
C) The company's cost of goods sold increased.
D) The company's depreciation expense declined.
E) The company's interest expense increased.
Answer: D
Q3) Free cash flow is the amount of cash that,if withdrawn,would harm the firm's ability to operate and to produce future cash flows.
A)True
B)False
Answer: False
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Page 5
Chapter 4: Analysis of Financial Statements
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Sample Questions
Q1) Companies HD and LD are both profitable,and they have the same total assets (TA),total invested capital,sales (S),return on assets (ROA),and profit margin (PM).Both firms finance using only debt and common equity.However,Company HD has the higher total debt to total capital ratio.Which of the following statements is CORRECT?
A) Company HD has a lower total assets turnover than Company LD.
B) Company HD has a lower equity multiplier than Company LD.
C) Company HD has a higher fixed assets turnover than Company LD.
D) Company HD has a higher ROE than Company LD.
E) Company HD has a lower operating income (EBIT)than Company LD.
Q2) HD Corp and LD Corp have identical assets,sales,interest rates paid on their debt,tax rates,and EBIT.Both firms finance using only debt and common equity,and total assets equal total invested capital.However,HD uses more debt than LD.Which of the following statements is CORRECT?
A) Without more information,we cannot tell if HD or LD would have a higher or lower net income.
B) HD would have the lower equity multiplier for use in the DuPont equation.
C) HD would have to pay more in income taxes.
D) HD would have the lower net income as shown on the income statement.
E) HD would have the higher operating margin.
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Page 6
Chapter 5: Time Value of Money
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Sample Questions
Q1) You have a chance to buy an annuity that pays $13,700 at the end of each year for 3 years.You could earn 5.5% on your money in other investments with equal risk.What is the most you should pay for the annuity?
A) $43,614.79
B) $31,417.43
C) $39,918.62
D) $39,549.01
E) $36,961.69
Q2) Suppose you have $850 and plan to purchase a 5-year certificate of deposit (CD)that pays 3.5% interest,compounded annually.How much will you have when the CD matures?
A) $837.91
B) $1,009.53
C) $888.39
D) $858.10
E) $777.34
Q3) A time line is meaningful even if all cash flows do not occur annually.
A)True
B)False
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Page 7
Chapter 6: Interest Rates
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Sample Questions
Q1) Suppose 1-year Treasury bonds yield 4.00% while 2-year T-bonds yield 5.10%.Assuming the pure expectations theory is correct,and thus the maturity risk premium for T-bonds is zero,what is the yield on a 1-year T-bond expected to be one year from now? Round the intermediate calculations to 4 decimal places and final answer to 2 decimal places.
A) 6.21
B) 7.39
C) 7.27
D) 5.47
E) 6.09
Q2) One of the four most fundamental factors that affect the cost of money as discussed in the text is the current state of the weather.If the weather is dark and stormy,the cost of money will be higher than if it is bright and sunny,other things held constant.
A)True
B)False
Q3) The "yield curve" shows the relationship between bonds' maturities and their yields.
A)True
B)False
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Page 8
Chapter 7: Bonds and Their Valuation
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Q1) Junk bonds are high-risk,high-yield debt instruments.They are often used to finance leveraged buyouts and mergers,and to provide financing to companies of questionable financial strength.
A)True
B)False
Q2) Which of the following statements is CORRECT?
A) If the Federal Reserve unexpectedly announces that it expects inflation to increase,then we would probably observe an immediate increase in bond prices.
B) The total yield on a bond is derived from dividends plus changes in the price of the bond.
C) Bonds are generally regarded as being riskier than common stocks,and therefore bonds have higher required returns.
D) Bonds issued by larger companies always have lower yields to maturity (due to less risk)than bonds issued by smaller companies.
E) The market price of a bond will always approach its par value as its maturity date approaches,provided the bond's required return remains constant.
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Chapter 8: Risk and Rates of Return
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Q1) Stock A has a beta of 0.8,Stock B has a beta of 1.0,and Stock C has a beta of 1.2.Portfolio P has 1/3 of its value invested in each stock.Each stock has a standard deviation of 25%,and their returns are independent of one another,i.e. ,the correlation coefficients between each pair of stocks is zero.Assuming the market is in equilibrium,which of the following statements is CORRECT?
A) Portfolio P's expected return is greater than the expected return on Stock B.
B) Portfolio P's expected return is equal to the expected return on Stock A.
C) Portfolio P's expected return is less than the expected return on Stock B.
D) Portfolio P's expected return is equal to the expected return on Stock B.
E) Portfolio P's expected return is greater than the expected return on Stock C.
Q2) If investors are risk averse and hold only one stock,we can conclude that the required rate of return on a stock whose standard deviation is 0.21 will be greater than the required return on a stock whose standard deviation is 0.10.However,if stocks are held in portfolios,it is possible that the required return could be higher on the stock with the lower standard deviation.
A)True
B)False
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Chapter 9: Stocks and Their Valuation
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Sample Questions
Q1) Which of the following statements is CORRECT?
A) Preferred stockholders have a priority over bondholders to the income in the event of a bankruptcy,but not to the proceeds in the event of a liquidation.
B) The preferred stock of a given firm is generally less risky to investors than the same firm's common stock.
C) Corporations cannot buy the preferred stocks of other corporations.
D) Preferred dividends are not generally cumulative.
E) A big advantage of preferred stock is that dividends on preferred stocks are tax deductible by the issuing corporation.
Q2) Suppose Boyson Corporation's projected free cash flow for next year is FCF<sub>1</sub> = $100,000,and FCF is expected to grow at a constant rate of 6.5%.Assume the firm has zero non-operating assets.If the company's weighted average cost of capital is 11.5%,then what is the firm's total corporate value?
A) $1,560,000
B) $1,900,000
C) $2,000,000
D) $1,980,000
E) $1,920,000
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Chapter 10: The Cost of Capital
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Q1) Which of the following statements is CORRECT?
A) The bond-yield-plus-risk-premium approach to estimating the cost of common equity involves adding a risk premium to the interest rate on the company's own long-term bonds.The size of the risk premium for bonds with different ratings is published daily in The Wall Street Journal or is available online.
B) The WACC is calculated using a before-tax cost for debt that is equal to the interest rate that must be paid on new debt,along with the after-tax costs for common stock and for preferred stock if it is used.
C) An increase in the risk-free rate is likely to reduce the marginal costs of both debt and equity.
D) The relevant WACC can change depending on the amount of funds a firm raises during a given year.Moreover,the WACC at each level of funds raised is a weighted average of the marginal costs of each capital component,with the weights based on the firm's target capital structure.
E) Beta measures market risk,which is generally the most relevant risk measure for a publicly-owned firm that seeks to maximize its intrinsic value.However,this is not true unless all of the firm's stockholders are well diversified.
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Chapter 11: The Basics of Capital Budgeting
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Sample Questions
Q1) The internal rate of return is that discount rate that equates the present value of the cash outflows (or costs)with the present value of the cash inflows.
A)True
B)False
Q2) Thorley Inc.is considering a project that has the following cash flow data.What is the project's IRR? Note that a project's projected IRR can be less than the WACC or negative,in both cases it will be rejected. \[\begin{array} { l c c c c c c }
\text { Year } & 0 & 1 & 2 & 3 & 4 & 5 \\ \hline \text { Cash flows } & - \$ 1,100 & \$ 325 & \$ 325 & \$ 325 & \$ 325 & \$ 325 \end{array}\] ? A) 14.59% B)
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Chapter 12: Cash Flow Estimation and Risk Analysis
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Sample Questions
Q1) Your company,CSUS Inc. ,is considering a new project whose data are shown below.The required equipment has a 3-year tax life,and the accelerated rates for such property are 33%,45%,15%,and 7% for Years 1 through 4.Revenues and other operating costs are expected to be constant over the project's 10-year expected operating life.What is the project's Year 4 cash flow? \[\begin{array} { l r }
\text { Equipment cost (depreciable basis) } & \$ 70,000 \\
\text { Sales revenues, each year } & \$ 34,000 \\
\text { Operating costs (excl. depr.) } & \$ 25,000 \\
\text { Tax rate } & 35.0 \% \end{array}\]
?
A) $8,700
B) $6,884
C) $7,565
D) $7,716
E) $8,473
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Chapter 13: Real Options and Other Topics in Capital
Budgeting
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Q1) Traditionally,an NPV analysis assumes that projects will be accepted or rejected,which implies that they will be undertaken now or never.However,in practice,companies sometimes have a third choice--delay the decision until later,when more information will be available.
A)True
B)False
Q2) Real options are most valuable when the underlying source of risk--such as uncertainty about unit sales,or the sales price,or input costs--is very low.
A)True
B)False
Q3) Which one of the following is NOT a real option?
A) The option to expand production if the product is successful.
B) The option to buy shares of stock if its price is expected to increase.
C) The option to expand into a new geographic region.
D) The option to abandon a project if cash flows turn out to be lower than expected.
E) The option to switch the type of fuel used in an industrial furnace to lower the cost of production.
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Page 15
Chapter 14: Capital Structure and Leverage
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Q1) The firm's target capital structure should do which of the following?
A) Maximize the earnings per share (EPS).
B) Minimize the cost of debt (r<sub>d</sub>).
C) Obtain the highest possible bond rating.
D) Minimize the cost of equity (r<sub>s</sub>).
E) Minimize the weighted average cost of capital (WACC).
Q2) El Capitan Foods has a capital structure of 36% debt and 64% equity,its tax rate is 35%,and its beta (leveraged)is 1.40.Based on the Hamada equation,what would the firm's beta be if it used no debt,i.e. ,what is its unlevered beta,b<sub>U</sub>?
A) 1.03
B) 1.29
C) 0.80
D) 0.88
E) 1.15
Q3) If a firm borrows money,it is using financial leverage.
A)True
B)False
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Page 16
Chapter 15: Distributions to Shareholders: Dividends and Share Repurchases
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Q1) Miller and Modigliani's dividend irrelevance theory says that the percentage of its earnings a firm pays out in dividends has no effect on its cost of capital,but it does affect its stock price.
A)True
B)False
Q2) Your firm adheres strictly to the residual dividend model.All else equal,which of the following factors would be most likely to lead to an increase in the firm's dividend per share?
A) The firm's net income increases.
B) The company increases the percentage of equity in its target capital structure.
C) The number of profitable potential projects increases.
D) Congress lowers the tax rate on capital gains,leaving the rest of the tax code unchanged.
E) Earnings are unchanged,but the firm issues new shares of common stock.
Q3) If the information content,or signaling,hypothesis is correct,then a change in a firm's dividend policy can have an important effect on its stock price and cost of equity.
A)True
B)False
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Chapter 16: Working Capital Management
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Q1) If one of your firm's customers is "stretching" its accounts payable,this may be a nuisance but it does not represent a real financial cost to your firm as long as the customer periodically pays off its entire balance.
A)True
B)False
Q2) The calculated cost of trade credit for a firm that buys on terms of 2/10,net 30,is lower (other things held constant)if the firm plans to pay in 40 days than in 30 days.
A)True
B)False
Q3) If a firm takes actions that reduce its days sales outstanding (DSO),then,other things held constant,this will lengthen its cash conversion cycle (CCC)and cause a deterioration in its cash position.
A)True
B)False
Q4) The three alternative current asset investment policies discussed in the text differ regarding the size of current asset holdings.
A)True
B)False
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18
Chapter 17: Financial Planning and Forecasting
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Q1) If a firm wants to maintain its ratios at their existing levels,then if it has a positive sales growth rate of any amount,it will require some amount of external funding.
A)True B)False
Q2) Last year Handorf-Zhu Inc.had $850 million of sales,and it had $425 million of fixed assets that were used at only 85% of capacity.What is the maximum sales growth rate the company could achieve before it had to increase its fixed assets?
A) 16.94%
B) 17.47%
C) 19.06%
D) 18.88%
E) 17.65%
Q3) If a firm with a positive net worth is operating its fixed assets at full capacity,if its dividend payout ratio is 100%,and if it wants to hold all financial ratios constant,then for any positive growth rate in sales,it will require external financing.
A)True B)False
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Page 19
Chapter 18: Derivatives and Risk Management
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Q1) A commercial bank recognizes that its net income suffers whenever interest rates increase.Which of the following strategies would protect the bank against rising interest rates?
A) Buying inverse floaters.
B) Entering into an interest rate swap where the bank receives a fixed payment stream,and in return agrees to make payments that float with market interest rates.
C) Purchase principal only (PO)strips that decline in value whenever interest rates rise.
D) Enter into a short hedge where the bank agrees to sell interest rate futures.
E) Sell some of the bank's floating-rate loans and use the proceeds to make fixed-rate loans.
Q2) An option that gives the holder the right to buy a stock at a specified price at some time in the future is called a(n)
A) Call option.
B) Put option.
C) Out-of-the-money option.
D) Naked option.
E) Covered option.
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Chapter 19: Multinational Financial Management
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Q1) The United States and most other major industrialized nations currently operate under a system of floating exchange rates.
A)True
B)False
Q2) Suppose that currently,1 British pound equals 1.98 U.S.dollars and 1 U.S.dollar equals 1.25 Swiss francs.How many Swiss francs are needed to purchase 1 pound?
A) 2.1285
B) 2.3760
C) 1.9058
D) 2.5988
E) 2.4750
Q3) If one U.S.dollar sells for 0.53 British pound,how many dollars should one British pound sell for?
A) 2.0566
B) 2.0943
C) 1.6792
D) 1.4906
E) 1.8868
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Chapter 20: Hybrid Financing: Preferred Stock,leasing,warrants,and Convertibles
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Q1) Quaid Co.'s common stock sells for $34.00,pays a dividend of $2.30,and has an expected long-term growth rate of 5.8%.The firm's straight-debt bonds yield an 11.20% return.Quaid is planning a convertible bond issue.The bonds will have a 20-year maturity,pay a 10.20% annual coupon,have a par value of $1,000,and a conversion ratio of 25 shares per bond.The bonds will sell for $1,000 and will be callable after 10 years.Assuming that the bonds will be converted at Year 10,when they become callable,what will be the expected return on the convertible when it is issued? Do not round your intermediate calculations.
A) 12.25%
B) 15.47%
C) 12.89%
D) 14.18%
E) 13.53%
Q2) Under a sale and leaseback arrangement,the seller of the leased property is the lessee and the buyer is the lessor.
A)True
B)False
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Page 22
Chapter 21: Mergers and Acquisitions
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Q1) A congeneric merger is one where the merging firms operate in related businesses but do not necessarily produce the same products or have a producer-supplier relationship.
A)True
B)False
Q2) The text gives a number of valid,acceptable reasons for companies to merge.Which of the following is NOT acceptable?
A) Synergistic benefits arising from mergers.
B) Reduction in competition resulting from mergers.
C) Acquisition of assets at below replacement value.
D) Attempts to minimize taxes by acquiring a firm with large accumulated losses that can be used immediately.
E) Using surplus cash to acquire another firm and prevent unfavorable tax consequences for shareholders.
Q3) Synergistic benefits can arise from a number of different sources,including operating economies of scale,financial economies,and increased managerial efficiency.
A)True
B)False
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